Do Emerging Managers add value ?

By: Peter Urbani (former) CIO, Infiniti Capital, Mar 2012

Why invest in Emerging Managers ?

Emerging Manager Funds (defined here as those Hedge Funds Funds which are less than 36 months old and have less than $300m in AUM) tend to be run by highly motivated, entrepreneurial and focused managers. In addition, the exploitable opportunity set they have identified in the marketplace is more likely to persist over the short-term. Simply put Emerging / Early Stage Managers try harder. All of this translates into excess returns or alpha of up to 400bp per annum*. It is fair to say that the price of this excess alpha is in the form of higher business risk associated with a start-up operation. This places a higher burden of responsibility on those performing qualitative due diligence to verify the managers ability to properly scale and grow their businesses. * Depending on which database is used some of this may be attributed to backfill and / or survivor bias. However, notwithstanding these biases, Emerging Managers deliver at least 200bp per annum in excess of the returns of established managers.

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Emerging Managers do have occasional periods of relative underperformance to established managers , typically after crisis periods, however the drawdowns associated with Emerging Managers are also lower.

Average return of Emerging Managers highest in first 3 years

Emerging M anagers versus Established M anagers

2500
Emerging Managers less than 12 months old and less than $100m AUM

1
2285

2000

Established Managers older than 12 months

1500

1000

874

500

0
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

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Average return of Emerging Managers highest in first 3 years

Emerging M anagers versus Established M anagers

2500
Emerging Managers less than 24 months old and less than $200m AUM

2
1735

2000

Established Managers older than 24 months

1500

1000 801 500

0
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

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Average return of Emerging Managers highest in first 3 years

Emerging M anagers versus Established M anagers

2500
Emerging Managers less than 36 months old and less than $300m AUM

3
1533
776

2000

Established Managers older than 36 months

1500

1000 711 500

0
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

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Excess Returns of Emerging Managers to Established Managers

99.84% Cumulative Excess returns over 19.25 years translates into annual excess return of + 3.66% p.a.

Cumulative Excess Returns of Emerging Managers

120
Excess Returns of Emerging Managers less than 36 months old and less than $300m AUM over Established Managers older than 36 months

100

100 99.84%

80

60

40

20
Periods of Relative underperformance to Established Managers

0
93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

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Why Emerging Managers They generate more Alpha

Emerging Managers versus Established Managers Analysis of 10,482 Funds from Eurekahedge Age and Size < 36 months and < $300m > 36 months < 24 months and < $200m > 24 months < 12 months and < $100m > 12 months < 6 months and < $50m > 6 months < 3 months and < $20m > 3 months All Mean Std Dev 14.79% 6.23% 11.14% 6.52% 15.39% 11.69% 16.75% 12.09% 17.47% 12.55% 18.02% 12.80% 13.11% 6.05% 6.54% 5.77% 6.51% 5.74% 6.47% 5.61% 6.43% 6.34%

Data from 31-Jan-93 to 31-Mar-12 Skew Kurt -0.26 1.79 -0.44 1.37 -0.13 1.34 -0.46 1.67 0.00 0.94 -0.42 1.68 0.34 0.78 -0.40 1.63 0.41 0.56 -0.40 1.67 -0.38 1.59 HPR 1533% 711% 1735% 801% 2285% 874% 2636% 963% 2941% 1016% 1086% Years 19.3 19.3 19.3 19.3 19.3 19.3 19.3 19.3 19.3 19.3 19.3 CAGR Alpha 15.61% 4.13% 11.49% 16.32% 4.22% 12.10% 17.91% 5.36% 12.55% 18.76% 5.69% 13.06% 19.41% 6.06% 13.35% 13.71%

Emerging Established Emerging Established Emerging Established Emerging Established Emerging Established All

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Emerging versus Established Manager Statistics

Emerging Managers 1532.89% 15.61% 14.79% 6.23% -0.26 1.79 -5.43% 7.21% 78.35% 21.65% -13.73% -1.72% -1.79% -1.79% -2.47% -3.17% -3.17% Established Managers 711.28% 11.49% 11.14% 6.52% -0.44 1.37 -6.85% 5.96% 69.70% 30.30% -19.45% -2.17% -2.34% -2.17% -2.95% -3.70% -2.95% Best Fit Distribution Sharpe ( Normal ) Sharpe ( Modified ) Sharpe ( Best Fit ) Omega ( LPM (1) ) Omega ( Normal ) Omega ( Best Fit ) Sortino ( LPM (2) ) CPTCE Emerging Managers Modified 0.50 0.39 0.39 5.90 3.06 3.96 1.56 0.31% Established Managers Normal 0.31 0.25 0.31 3.52 2.22 2.22 0.97 -0.02%

Key Statistics: HPR CAGR Annual Return Annual SD Skew Kurtosis Worst Month Best Month % Pos % Neg Max Drawdown VaR ( Normal ) VaR ( Modified ) VaR ( Best Fit ) CVaR ( Normal ) CVaR ( Modified ) CVaR ( Best Fit )

Emerging Managers better by every metric except CVaR ( Best Fit )

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Best Fit Distributions for Emerging and Established Managers

Note: Higher Kurtosis translates into slightly fatter tails for Emerging Managers as expressed by the higher CVaR / Expected Shortfall

Best Fit Distributions

Best Fit Emerging Managers less than 36 months old and less than $300m AUM PDF (Modified Normal) Best Fit Established Managers older than 36 months PDF (Normal)

Best Fit VaR -1.79% Best Fit VaR -2.17% Best Fit CVaR -3.17% Best Fit CVaR -2.95%

But this is compensated for by higher upside returns

-15.00%

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

This chart shows the Best Fit distributions of the Fund and the Benchmarks. Its is demonstrating the Upside Potential or Shortfall of the Fund Relative to the chosen Benchmarks.

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Emerging versus Established Manager Drawdowns (12m)

Generally lower Drawdowns for Emerging over Established Managers
0.00% -2.00% -4.00% -6.00% -8.00% -10.00% -12.00% -14.00% -16.00% -18.00% -20.00% 12 Month Rolling Drawdowns Emerging Managers less than 36 months old and less than $300m AUM 12 Month Rolling Drawdowns Established Managers older than 36 months -18.95% -5.50% -6.52% -0.71% -2.82% -6.59% -8.71%

-13.73%

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ec -9 3 D ec -9 4 D ec -9 5 D ec D 96 ec -9 7 D ec -9 8 D ec -9 9 D ec -0 0 D ec D 01 ec -0 2 D ec -0 3 D ec -0 4 D ec -0 5 D ec D 06 ec -0 7 D ec -0 8 D ec -0 9 D ec -1 0 D ec -1 1

Emerging versus Established Manager Best Fit VaR ( 95% )

Generally lower VaRs for Emerging over Established Managers
2.00% 1.00% 0.00% -1.00% -2.00% -3.00% -4.00% -5.00% -6.00% -7.00% -8.00% 12 Month Rolling Emerging Managers less than 36 months old and less than $300m AUM Best Fit VaR (95.00%) 12 Month Rolling Established Managers older than 36 months Best Fit VaR (95.00%)

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ec -9 3 D ec -9 4 D ec -9 5 D ec -9 6 D ec -9 7 D ec -9 8 D ec -9 9 D ec D 00 ec -0 1 D ec -0 2 D ec -0 3 D ec -0 4 D ec -0 5 D ec -0 6 D ec -0 7 D ec -0 8 D ec -0 9 D ec -1 0 D ec -1 1

Average time taken to achieve various AUM milestones

Only 3.7% of Funds grow their AUM to more than $1bn

Time to achieve AUM Milestones versus % Achieving AUM

1500 1400 1300 1200 1100 1000 900 800 700 600 500 400 300 200 100 26 0 0 0% 9.39% 7.80% 3.72% 1416 10% 20%

After 16 months the 21.19% of Funds whose AUM > $100M have an average AUM of $131m

AUM $m

40% 50% 587 60% 70% 80% 90% 100%

345 131 5 10 15 20 237

449 Average Fund Size at time % of Funds achieving AUM

25

30

35

40

45

50

55

60

Average time in Months

The average size of a fund at launch is $25.6m

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It takes on average 16 months for AUM to exceed $100m

It takes them 55 months to do so

% Achieving AUM

21.19%

15.27%

11.68%

Only 7.8% of Funds grow their AUM to more than $500m

30%

Average return of Emerging Managers highest in first 3 years

Average Hedge Fund Returns versus Age in Months
14.0% 13.0%

Returns ( Annualised )

12.0% 11.0% 10.0% 9.0% 8.0% 7.0% 6.0%

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The Seven Year Itch ?

8.52%

12 18 24 30 36 42 48 54 60 66 72 78 84 90 96 102 108 114 120 126

Age in Months

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Note: This study is independent of time in that we pose the question as How does a manager perform during his/her first 36 months irrespective of when they occur

Comparison to other Emerging Manager Indices

Emerging v.s. Established and Large Indices
Eurekahedge < 36 months old and < $300m AUM - CAGR: 14.94% Opalesque Emanagers Total Index - CAGR: 14.62% Eurekahedge All - CAGR: 13.09% HFR New Managers Index - CAGR: 11.71% Eurekahedge > 36 months old - CAGR: 11.02% TOP 100 Funds by AUM - CAGR: 10.96% 600 HFR Established Managers Index - CAGR: 9.25%

1200

1000

800

400

200

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19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11

Note Poor performance of Top 100 (Large Funds) by AUM

Comparison to other Emerging Manager Indices

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What of Survivorship Bias ?

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Supporting Literature
Emerging managers have particularly strong financial incentives to create performance and may be more nimble than established ones. We find strong evidence of outperformance during the first two or three years of existence. Emerging managers, narrowly defined as having a maximum life of two years, generate an abnormal performance of 2.3% relative to the later years. This difference is statistically and economically significant. Aggarwal and Jorion - The Performance of Emerging Hedge Fund Managers Young funds outperform seasoned funds after adjustment for risk of failure. Investors should buy young funds in the first three years of their existence. Michael Howell, Managing Director, Crossborder Capital - The Young Ones

Emerging managers, defined as managers with less than a two year track record, exhibit compelling absolute return profiles and have typically outperformed the overall hedge fund market.
HFR Asset Management - Emerging Manager Out-Performance: Our conclusion is that despite the biases found in the data, investors may gain enhanced returns by investing in young hedge funds if proper due diligence is completed. Hedge funds under three years of age tend to perform better than do older hedge funds without necessarily adding to the volatility of returns. Lazard Asset Management - Early Performance In Hedge Fund Managers From Jan. 1, 2004, through Dec. 31, 2005, 167 "emerging managers" those who started funds in 2003 and had $30 million to $250 million in assets outperformed two leading hedge fund indexes. The class of 2003, or the 167 managers measured on an equal-weighted basis, returned 11.39 percent in 2004, compared with the MSCI equal-weighted index, at 6.55 percent, and the Credit Suisse/Tremont investable index, at 5.31 percent. Mayer & Hoffman Capital Advisors - Investing in Newer Hedge Funds P.21

Opalesque Emerging Managers Monitor

For more on Emerging Managers see:
http://www.scribd.com/peter_urbani/d/84414603-Opalesque-New-Managers-Jan-2012

http://www.scribd.com/peter_urbani/d/84414826-Opalesque-New-Managers-Feb-2012
http://www.scribd.com/peter_urbani/d/86519461-Opalesque-New-Managers-March-2012 http://www.scribd.com/peter_urbani/d/91429400-Opalesque-New-Managers-April-2012 http://www.scribd.com/peter_urbani/d/94991537-Opalesque-New-Managers-May-2012

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Important Notes
The information contained herein (the "information") is intended for illustrative purposes only, has been developed internally and has been based on variations of existing funds, managed accounts, simulations, extrapolations of other investment programs, pro forma data or taken from trade and statistical services and other sources that we deem reliable, although no warranty is made that the information is accurate or complete and it should not be relied upon as such. The information is not intended to depict or predict actual investment performance of any financial product and is subject to change without notice. Any opinions expressed herein reflect Infiniti Capitals judgment at the date and time hereof and are subject to change without notice. The information should not be construed as legal, tax, investment or other advice. This does not constitute an offer to sell, or the solicitation of an offer to buy, any product. An offer may only be made by means of the offering memorandum and governing documents of the relevant funds (the "Fund Documents"), which should be read in their entirety. The information is not intended to be complete or final and is qualified in its entirety by the Fund Documents. In the event the Information is inconsistent or contrary to the descriptions or terms of the Fund Documents, the terms of the Fund Documents shall prevail. Interests in the funds are privately offered to investors who satisfy the eligibility criteria described in the Fund Documents. The Information is CONFIDENTIAL. It is intended only for the use of the person to whom this document is given and may not be reproduced or redistributed. Any securities discussed herein may not be suitable for all investors. Transactions of the type described herein may involve a high degree of risk, and the value of such instruments may be highly volatile. Past performance is not guarantee of, and cannot be construed as an indication of, future results.

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